Real Estate Settlement Procedures Act (RESPA): What Is It And How Does It Work?
Lauren Nowacki4-Minute Read
February 10, 2022
As with any financial transaction, there’s always someone trying to find a way to make more money – often at the expense of another. Luckily, there are federal laws in place to protect both buyer and seller when it comes to real estate transactions. The Real Estate Settlement Procedure Act, also known as RESPA, is one of those laws.
If you’re buying or selling a home and a mortgage is involved, you’ll want to know about it.
What Is RESPA In Real Estate?
RESPA is a federal protection law that guarantees lenders and settlement providers will disclose the cost of closing. This law prohibits unearned fees, like kickbacks, and ensures that buyers and sellers receive complete disclosures on their real estate settlement costs.
The Consumer Financial Protection Bureau (CFPB) oversees this law with the purpose of regulating certain aspects of the closing and settlement process in a real estate transaction to protect individuals when buying a house.
The History Of RESPA
In 1974, Congress passed RESPA to reduce settlement costs and prohibit illegal or unearned fees, such as kickbacks and referral fees, which can drive up the settlement costs. Thanks to RESPA, these fees could no longer be included in the costs to purchase a home.
The Department of Housing and Urban Development was originally in charge of enforcing this law, but it has since moved to the jurisdiction of the CFPB, a government agency responsible for protecting and educating consumers about financial services and products.
RESPA was designed to ensure that home buyers receive the complete disclosures on their real estate settlement costs and understand the costs and terms associated with purchasing a hoe. This helps them make informed decisions on their real estate transactions, while also protecting them from added fees.
How Is RESPA Used In Real Estate?
RESPA is used to protect home buyers and sellers in real estate transactions by requiring the disclosure of all settlement costs, which helps prevent “hidden fees” from things like kickbacks, referrals and escrows, which may make it more expensive to close your loan.
Often referred to as a form of bribery, kickbacks are illegal payments or other incentives used as compensation for performing undisclosed services, such as recommending certain businesses or products or showing preferential treatment.
Per Section 8 of RESPA, individuals and businesses are prohibited from accepting or providing any kind of kickbacks, unearned fees and fee-splitting.
Regulates Escrow Accounts
Section 10 of RESPA regulates the use of escrow accounts by prohibiting loan servicers from requiring excessively large escrow accounts. The law limits escrow accounts to only the funds necessary to pay for such charges as property taxes and homeowners insurance.
To determine this amount, the servicer will add the prior annual property tax and your insurance premium amount, then divide it by 12 to get the monthly escrow payment amount. This amount is part of your monthly mortgage payment. You should receive an escrow account statement that breaks down your payment to show how much you’re paying in escrow. Keep in mind, your escrow account is analyzed each year and may increase or decrease throughout the years as property taxes fluctuate annually.
Bans Title Insurance Mandates
RESPA prevents home sellers or their attorneys from directly or indirectly mandating that mortgage loan borrowers purchase title insurance from specific companies as a condition of selling the property. This provision is outlined in Section 9 of the law.
What Information Does RESPA Require To Be Disclosed?
RESPA requires different disclosures throughout the home buying process. From application to closing, you’ll receive information on settlement costs, lender servicing and escrow account practices, and business relationships between settlement service providers.
What Are The Disclosures You Need For RESPA?
At certain steps in the mortgage process, homebuyers will receive disclosures. Here are the disclosures you can expect to review and when you can expect them.
1. Disclosure Statements When Applying For A Loan
The first disclosures come when you apply for a mortgage loan. You’ll get three separate disclosure statements once you apply.
- Special information booklet: This booklet explains closing costs and escrow accounts and the RESPA settlement practice. It will also warn you of the different types of unfair practices and charges and red flags to watch out for in the settlement practice.
- Good Faith Estimate: The 2008 RESPA Reform Rule required a standardized Good Faith Estimate (GFE), an estimate provided by the lender that lists the costs and terms of the mortgage loan. This can help you compare costs and loan terms between different lenders.
- Mortgage Servicing Disclosure: It’s common practice for lenders to sell loans once they close. This disclosure from the lender will tell you whether the lender intends to service your loan or transfer it to another lender for servicing. The mortgage servicing disclosure also provides information complaint resolution.
2. Disclosures Before The Real Estate Settlement
Before the real estate settlement, also known as the closing, you can expect to receive the following disclosures.
- Affiliated business arrangement disclosure: If you’re referred to a business, the person who referred you must disclose to you the relationship and financial interest between themselves and the business they referred. Keep in mind that you are not required to use the business that was referred to you. If you are told that you’re required to use the referral or pressured to use the referral, that may be a RESPA violation.
- HUD-1 Settlement Statement: This statement will list all the settlement charges that you or the seller are responsible for paying. It will also list your credits, if you have any.
3. Disclosure Settlements For A Mortgage Closing
These are the Closing Disclosures that are necessary when reaching the real estate settlement.
- HUD-1 Settlement Statement: As mentioned above, the HUD-1 Settlement Statement shows the settlement costs of the transaction. You’ll receive a final statement that shows the actual costs at closing.
- Initial escrow statement: This will tell you how much you’re expected to pay for your homeowners insurance, property taxes and other charges in the first 12 months of owning your home. This money is put into an escrow account and paid from that account throughout the year when these charges are due. This document will also tell you how much you’ll pay into the account each month. Keep in mind that, after your first year and each year after, the amount of money needed to fund your escrow account may change as property taxes change annually.
4. Disclosure After The Real Estate Settlement
Since property taxes change annually and homeowners insurance costs may change as well, your loan servicer must give you an annual escrow statement once a year to make you aware of any changes to the amount you’re paying into your escrow account. The document will also breakdown all the payments made into the account and all payments taken out of the account during the previous year. It will also let you know if you have an escrow surplus or shortage. If you have a surplus, it means you paid more into your account than was needed and may get some money back. If you have an escrow shortage, it means that you didn’t pay enough into the account and must pay the difference.
What Are RESPA Violations?
RESPA violations are actions – or inactions – that go against RESPA requirements. Here are a few examples.
- Using payments in exchange for referrals: This violation of RESPA happens when a person makes or receives a payment in exchange for a referral of a settlement service.
- Inflating costs: If a company charges more for a service than they normally do, that’s a RESPA violation. Examples of this are if a mortgage broker charges buyers more for a credit report than they paid to pull it.
- Setting up shell entities to receive kickbacks: This is often done to hide the fact that the business is collecting kickbacks or referral fees. Shell entities are incorporated companies with no significant assets or business operations.
How Are RESPA Violations Enforced?
Violating RESPA can come with severe penalties, including lawsuits, fines and imprisonment.
For example, the liabilities for violating Section 8 kickbacks rules can include a fine of up to $10,000 and/or up to one year in prison. For violating Section 9 bans on title mandates, the seller could be found liable to pay up to three times the cost of the insurance paid by the borrower. And when it comes to escrow account violations, HUD may impose a civil penalty on the servicer.
Those who feel like their service provider violated RESPA should file a complaint with HUD or their servicer (depending on the violation). Keep in mind that some of these incidents have timelines. For example, those with kickback violation complaints may have one year to file suit.
Servicing complaints must be given to the loan servicer in writing and the servicer must provide written acknowledgment of the complaint within 20 business days of receiving it. The servicer then has 60 business days to correct the issue or validate the state of the account.
The Bottom Line
The purpose of RESPA is to protect real estate buyers and sellers from unnecessary payments. This is done in part through fee disclosures that not only help you spot red flags and budget correctly but also help you compare costs to find the best lender.
If you suspect that you’ve been a victim of a RESPA violation or are currently experiencing one, we recommend contacting a closing attorney. They’ll be able to answer questions, offer advice, provide the right contacts and help walk you through the legal process.